Foreign Exchange Markets

This chapter uses production possibilities curves, discussed in Chapter 1.

This chapter uses supply and demand, discussed in Chapter 2 Graphic Detail.

The foreign exchange market is very similar to a product or factor market (discussed in previous chapters) except that what is traded in a foreign exchange market is a country's currency. For example, there are markets for Mexican Pesos and Japanese Yen. In these markets, quantity refers to the quantity of the currency (Pesos or Yen). The price of the currency is expressed in dollars. A graph of the market for Mexican Pesos is shown below.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=jpg::::/sites/dl/free/007340280x/520423/Ch10_img1.jpg','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif"> (37.0K)</a>

The supply and demand curves look the same as supply and demand curves in product markets and for largely the same reasons. However, the reasons why buyers and sellers purchase and sell foreign currency are different. People from the U.S. buy Pesos in order to import goods from Mexico or if they want to invest in Mexico . A U.S. citizen traveling in Mexico would also need to buy Pesos to spend while abroad.

Individuals from the U.S. who export goods to Mexico are paid in Pesos. They will supply pesos in the foreign exchange market to change the pesos for U.S. Dollars. Mexicans who wish to invest in the U.S. will supply Pesos in exchange for Dollars, as will Mexican travelers to the U.S.

U.S. dollars are used in the U.S. economy. Pesos are used in the Mexican economy. Anytime an individual has Pesos and wants to buy in the U.S. or has U.S. Dollars and want to buy in Mexico , she will have to exchange currency in the foreign exchange market.